Prolonged government shutdowns, continuing supply chain disruption, and rising concerns about the efficacy of federally issued relief have left many lenders, borrowers, and servicers wondering whether payouts on business interruption insurance could provide Main Street with a much needed liquidity boost. In this distribution, Harbor Group explains the basics of Business Interruption coverage, how it might perform against COVID-19 losses, and importantly, who will bear the short and long term costs of an insurance industry backed relief effort.
Can or will owners and operators be able to rely on Business Interruption coverage to recoup income lost as a result of COVID-19? The short answer is, maybe – recent, ongoing developments in state and federal legislation might make the broad availability of proceeds much more likely than most in the industry previously thought.
As it stands, there are three primary, potential avenues for insured parties looking to recoup lost income with insurance proceeds:
Language, Litigation, and Legislation.
Language: Contagious disease, virus, or pandemic as a covered cause of loss
Whether a commercial property insurance policy will respond to losses incurred as a result of COVID19 depends on the insurance policy contract language, and importantly, whether there are any specific endorsements or exclusions present that may modify the standard form.
In order to trigger coverage under a standard Business Interruption Coverage Form, the following two elements must be met:
(1) direct physical loss or damage to the property
(2) caused by a covered cause of loss under the policy
For example, if a property sustains structural damage due to a fire that ultimately renders a business inoperable, the Business Interruption component of the property policy would likely trigger, because the income loss occurred as a result of direct physical damage to the property, the cause of which, (fire), is a standard covered cause of loss under an All-Risk policy.
With respect to COVID19, however, insurance outcomes in similar circumstances suggest that most policies are unlikely to trigger business interruption coverage because the presence of a virus does not typically meet the definition of physical loss or damage to the property. In addition, some coverage forms specifically exclude Virus, Communicable Disease, and Pandemic as covered causes of loss.
Some policies may include highly specialized, or “manuscripted,” policy endorsements, such as Communicable Disease Additional Coverage, Loss of Attraction, or Cancellation of Books, as examples, and these may provide coverage for loss of income without physical damage. Manuscripted endorsements are not part of a standard All-Risk policy – they are “add-on” provisions – and typically tied to a sub-limit, which means only a specified, reduced amount of coverage is available. Here, the specific endorsement language would be critical to any determination of applicable coverage.
Civil Authority coverage, which covers loss of business income due to the actions of civil authorities, is another specialized coverage that may provide an opportunity to recoup losses arising out of virus-related shutdowns. Like standard business interruption coverage, however, Civil Authority coverage typically contains a physical damage requirement; commonly, that the action of a civil authority prohibits access to the insured property, and is taken in response to dangerous physical conditions resulting from physical damage or continuation of a covered cause of loss that caused physical damage to a nearby property. Here too, the inability to demonstrate physical loss or damage caused by a virus is a likely bar to coverage, however specialized endorsements may provide an avenue for coverage under an articulated covered cause of loss. Not all policies, endorsements, or exclusions are clear, and the novel nature of losses incurred as a result of COVID19 leaves open the possibility for a re-interpretation of existing language, or even a change in coverage availability altogether.
Litigation: Utilizing the judiciary to determine the scope of coverage
Absent specific policy language, the question of whether a virus can cause direct physical loss or damage to a property is an issue of fact that lacks direct historical precedent. It’s also one that is likely to be heavily litigated in the wake of claims arising out of income losses due to COVID19.
U.S. Courts have previously examined whether other causes of loss with characteristics similar to COVID19 met the standard policy form definition of “physical damage” and have typically found, with exceptions, that they do not. For example, one District Court held that asbestos contamination did not constitute a physical loss because the building had remained unchanged, while another opined that offensive odors and the presence of mold and bacteria in a building’s HVAC system were intangible harms that did not constitute physical damage to property. Additionally, in two separate cases, U.S. Courts declined to define either roadwork debris or mold as direct physical damage where the aforementioned could be cleaned or remediated. In all four cases, the lack of direct physical loss or damage resulted in the unavailability of Business Interruption coverage.
At least one court took an alternative view, finding that physical property damage had occurred where an accidental release of ammonia rendered a facility unsafe until it could be aired out and cleaned. Notably, the Court’s decision rested upon its determination that a property can sustain physical damage even if no structural alteration of the premises occurs.
Litigation of these same questions with respect COVID-related losses has already begun. Last week, a California restauranteur filed a heavily publicized suit in response to an insurance company determination that coronavirus contamination does not constitute a physical loss under its policy terms. If allowed to move forward, the case, or others like it, has the potential to set judicial precedent for the estimated billions in business interruption claims that may ultimately make their way to the courts.
Legislation: Backstopping relief efforts through mandated, retroactive insurance coverage
As lawmakers work to stabilize businesses impacted by COVID-19, many state and federal legislators are looking to reinterpret the availability business interruption insurance as a potential windfall for business operators in need of financial relief. Multifaceted legislation is currently being drafted at both the state and federal levels with two goals in mind: 1) utilize mandated insurance payouts to bolster financial relief for businesses affected by COVID-19, and 2) enact federal legislation to guarantee the availability of insurance coverage in the event of a future pandemic.
New Jersey was the first of several States to introduce legislation that would require every property insurance policy providing coverage for business interruption, and-or for loss of use or occupancy, to explicitly include business interruption occurring during the period of a declared COVID-19 state emergency as a covered cause of loss. These mandates effectively nullify policy exclusions that would preclude coverage eligibility where losses were the result of COVID-19, but stop short of an explicit declaration of physical damage or loss, thus leaving threshold determinations as to the nature of the damage to insurance providers, or alternatively, the courts.
On March 31st, a coalition of more than 30 trade organizations submitted their proposal for the creation of a COVID-19 Business and Employee Continuity Recovery Fund backed by the federal government, which presents a possible solution to the solvency concerns articulated by NAIC. The fund would operate in a manner similar to the existing SBA program, in this case via special administrator contracts engaged with a range of liquidity providers, including lenders and insurers, who would facilitate the distribution of federal funds to businesses impacted by COVID-19. Were the fund to operate as proposed, insurers could operate as effective conduits for government backed payouts on business losses, either by utilizing existing business interruption coverage contracts as a pre-formed path to distribution, or by supplementing a discounted, mandated insurance payout with federal funds. Negotiations with federal lawmakers are ongoing, however the potential for federal financial backing of some or all of the proposed retroactive business interruption payouts presents the opportunity to equitably stabilize businesses in economic distress without trading it in exchange for a complete destabilization of the insurance industry.
In addition to legislation aimed at recovery, House reps are currently drafting a forward looking counterpart to the Terrorism Risk Insurance Act, tentatively titled the “Pandemic Risk Insurance Act,” (PRIA) which would guarantee the availability of insurance coverage against losses arising out of circumstances similar to COVID-19. Importantly, PRIA is currently being drafted as a go-forward program rather than one that would provide retroactive relief for COVID related losses, however proposals to combine a newly formed PRIA with the existing TRIA/TRIPRA premium pool could provide some opportunity to access retroactive relief, and-or to provide retroactive, virus-related coverage to insured parties currently carrying TRIPRA-mandated terrorism insurance.
Specific definitions and scope of the proposed Act are as-yet unpublished, but House members have confirmed that regardless of whether it ultimately stands as an independent program or as an amended addition to TRIA/TRIPRA, the purpose and operation of PRIA, as with TRIA, will be to require commercial insurers to offer insurance coverage against pandemic related losses. Claims paid under the definitions of the Act would be subject to reimbursement by the federal government, less any deductible and retention amounts.
The role of insurance as a mechanism of economic recovery for lenders, borrowers, and the market as a whole is continuing to evolve at a rapid pace. As the leading insurance consultant to securitized CRE Lenders and investment institutions, Harbor Group will continue to partner with the MBA and other trusted organizational partners in our daily tracking of the recovery effort – you will find our go-forward updates in the MBA’s Industry Recovery Snapshot Bulletin.
For 25 years, Harbor Group consultants have served as your lighthouse in the industry risk storm – we are here to help you navigate this one, too.